Taking short hops

With the winds of winter behind it, the turbulent industry finds itself traveling a smoother course than in the past seven years. Many airlines are making money, carriers have become more efficient, there's potential for raising fares and some of their stocks might be worth buying.

Realistically, Southwest Airlines Co. is probably the only stock investors could stash in their retirement accounts with long-term confidence. The rest are for daring souls willing to buy and sell."We think this is a turnaround year, with the airline group making about $4 billion," said Vaughn Cordle, chief executive of AirlineForecasts LLC in Washington, D.C., which does research and consulting for groups such as hedge funds.

"In the short run, the industry looks robust, even though it is fundamentally bad and cannot earn its cost of capital over the full cycle."

Some estimates for this year's industry earnings approach $6 billion, based on expected record passenger traffic and especially strong performance in the second and third quarters. That would eclipse the $5.4 billion industry record set in 1999.

"It's going to be a crowded summer, and it is getting harder and harder to fly," said Ray Neidl, airline analyst with Calyon Securities in New York. "But let's face it, it is still a very efficient system that does a commendable job of getting people where they want to go with their luggage, especially considering the cost and the crowds."

Passenger load factors will be at record levels, in part because most major carriers have cut back their domestic capacity.

Meanwhile, revenue per passenger mile is 25 percent lower than in 2000, an indication that this is not an easy business.

The major carriers now account for 68 percent of industry capacity, as their dominance continues to erode. Their share has been chipped away by high-roller passengers who take private aircraft and budget-conscious travelers who opt for discount carriers. One advantage major carriers do have is that, unlike the discounters, they are not under constant pressure to grow in order to survive and thrive.

"Airline stocks are generally trading vehicles with short time horizons that have to be continually re-evaluated," said Jim Corridore, airline analyst with Standard & Poor's Equity Research Services in New York. "Almost every stock I cover, except for Southwest Airlines, is categorized as high risk and generally should not be in a 401(k) retirement account."

Every time oil prices shoot upward, companies and analysts revise their earnings estimates. When prices come down again, often within a tight time frame, they do it all over again. Analysts are constantly formulating bull and bear fuel scenarios, taking into account volatile fuel costs. Neidl, for example, believes the industry is capable of making money with oil at $60 a barrel.

Stocks of airlines often decline in the summer and rise in the winter. With all the variables and caveats of the industry kept in mind by potential investors, some airline stocks are worth a look.Corridore and Neidl recommend Alaska Air Group Inc., AMR Corp., parent of American Airlines, Continental Airlines Inc. and US Airways Group Inc.

Southwest Airlines is recommended by Corridore, and UAL Corp., parent of United Airlines, is favored by Neidl.Cordle forecasts that Canadian carrier WestJet Airlines Ltd. will be the most profitable carrier in the industry this year, as it flies aggressively into the U.S., while Southwest Airlines will rank second. WestJet's profit margins the past 12 months have been about 11 percent, compared with 10 percent at Southwest, he said.This is an industry that always will court its share of trouble, so some carriers inevitably don't receive the highest marks.

Cordle said JetBlue Airways Corp., whose aggressive growth came home to roost when it couldn't cope with the effects of winter storms, remains an overvalued stock. It has brought capacity down and brought in a new management team but still has problems to solve related to its dramatic passenger growth last year, he said.

Corridore advises investors to unload shares of regional carrier Mesa Air Group Inc. because its fare-war strategy in Hawaii is suspect. He also would sell shares of another regional firm, ExpressJet Holdings Inc., because Continental has been shifting away from it. ExpressJet's decision to fly some other planes on its own doesn't look promising, experts said.

Sell Northwest Airlines Corp. because its shares will become worthless once the company exits bankruptcy and new stock is issued primarily to unsecured creditors, Neidl added.

The market appears ready for airline consolidation, though government regulators would have to give their blessing to deals.

The fact the industry is rising makes mergers a little less likely, since consolidation usually takes place during a downward cycle. Thus far, US Airways' bid for Delta hasn't panned out, and Midwest Air Group Inc. has rebuffed a takeover offer by AirTran Holdings Inc.

Andrew Leckey is a Tribune Media Services columnist. E-mail him at yourmoney@tribune.com.